Hydrogen energy is an alternative to carbon fuels going up in smoke. But for shareholders in hydrogen energy group ITM Power (LSE: ITM), what has gone up in smoke over the last year is half the value of their holdings. The ITM Power share has tumbled 53% in 12 months, at the time of writing this article yesterday.
Could that be a buying opportunity for my portfolio? I do not think so. Here is why.
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The ITM business model
ITM has spent years developing its own technology. It has built a factory to churn out the product at commercial scale, not just the sorts of prototypes built in labs to test the concept. Indeed it has already agreed to a site for a second factory in the UK and is now also talking about the prospect of building a factory overseas.
The idea is that the company ramps up sales, making use of its expanding manufacturing footprint. As it grows relationships with customers such as Shell and attracts new ones, revenues should grow. That will help it better cover its fixed costs and hopefully move from loss to profit.
That is a pretty standard approach for a company in an emerging industry. One thing about ITM that sets it apart from less well-funded startups is its ability to burn through cash. Last year, for example, net cash burn before fundraising was £32.7m. For now, liquidity is not a problem. The company has simply kept raising funds. In October, for example, it raised another £250m by selling shares.
What happens when a company does that is the newly issued shares dilute existing ones. More shares in circulation lead to each one representing a smaller fraction of the company. Given its history of burning through cash and ambitious expansion plans, I think further shareholder dilution remains a risk for ITM shareholders.
Bull case for ITM
ITM’s technology is attracting serious customers. There have been some positive news announcements lately, including a contract signed to deliver 12MW of electrolysis equipment this year.
As the company scales, its production costs should achieve economies of scale. Globally many customers are looking for alternatives to carbon fuels. Hydrogen energy is one option and ITM could take some of the hydrogen market. If that happens, and it can convert sales into profits, shareholders could see an improving share price.
Where next for the ITM Power share price?
I remain sceptical that that will happen, though. I do expect a sharply improving sales outlook, based on the company’s forecast. But revenue in the six months to October was only £4.1m. With a market capitalisation close to £2bn even after the share price fall, those revenues look miniscule to me. Meanwhile, in the same period the company reported a gross loss of £2.4m and burned through another £12m.
If the economics of hydrogen energy do turn out to be attractive I expect strong competition. That could push down profit margins across the industry. If the economics fail to improve, however, I do not foresee a long-term profitable business model at scale for ITM. Despite the fall in the ITM Power share price, I will not be buying it for my portfolio.